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High Inflation Disrupts Retirement Savings Strategies

401(k) plans can consider funds that hedge against inflation

A woman is sitting at a table with a calculator and papers.

This article has been updated.

Surging inflation in 2022 has many older employees worried if they've saved enough and if the buying power of their savings will continue to fall in relation to rising prices. It's also causing retirement plan sponsors to re-evaluate the investment options offered in their plans.

In May, the year-over-year increase in consumer prices hit a 40-year high of 8.6 percent, according to the U.S. Bureau of Labor Statistics. Many economists expect inflation to remain elevated through 2022 and into 2023.

Higher inflation not only means the buying power of workers' take-home pay is shrinking, but that the value of the dollars in their 401(k)s and similar retirement plans won't go as far as they might have hoped.

Voya Financial's consumer research survey, conducted March 29-30 with responses from 1,000 U.S. adults, found that:

  • 66 percent of respondents are worried about how inflation will affect their ability to save for retirement.
  • 73 percent of Millennials and 74 percent of Generation X are worried about inflation's effect on their retirement savings.
  • 43 percent of respondents because of inflation have had to tap into finances that they previously had set aside for retirement.

"All generations, particularly those balancing the impact of competing financial priorities today, are feeling the impact inflation has on their ability to save for the future," said Heather Lavallee, CEO of wealth solutions for Voya Financial.

"Resources such as health savings accounts [HSAs] to offset the burden of medical costs, student loan debt support and tools for building emergency savings continue to grow in popularity as employer wellness benefits," giving employees more opportunities to save for a secure financial future, she added.

Spending Habits

"For those currently retired, inflation risk is very real and will impact both how much retirees can withdraw from their portfolio and their lifestyle in retirement," said Dylan Huang, head of retirement and wealth management solutions at benefits provider New York Life. "Among those not yet retired, we're seeing this group making necessary adjustments to their financial strategies while not allowing short-term anxiety to derail their plans for retirement."

A MetLife poll conducted in March 23-25 found that, among 4,416 U.S. adults, top changes they're making to maintain or increase contributions to their retirement savings range from cutting back on social activities, nightlife and travel, to holding off on larger expenditures like home renovations or having more children.

Retirement Plan Savings

The percentage of working Americans nearing retirement age (60-67 years old) who said they have enough money saved was just 22 percent this year, down from 26 percent a year ago, according to asset management firm Schroders U.S. Retirement Survey 2022, conducted in February among 1,000 U.S. investors nationwide ages 45 to 75.

The top three concerns Americans have about retirement were:

  • Inflation lessening the value of assets (65 percent of respondents).
  • Higher than expected health care costs (64 percent).
  • A major market downturn significantly reducing assets (53 percent).
"There's no question that rising inflation and market volatility have taken a toll on Americans' belief in being able to achieve a financially comfortable retirement," said Joel Schiffman, head of intermediary distribution at Schroders. 

In 401(k)s and other defined contribution plans, "all risk, including inflation risk, is held by the participant," wrote Mike Barry, a Chicago-based senior consultant with October Three Consulting, a retirement plan advisory firm.

If retiring plan participants use their 401(k) savings to purchase an annuity that makes fixed monthly payments—or have an annuity-buying option within their plan—inflation can, in just a few years, substantially decrease the buying power of the annuitized payments.

The same is true for a defined benefit pension's monthly payouts, unless the pension includes annuity cost-of-living adjustments, which few private-sector pensions do.

Inflation can also increase the volatility of stock funds, Barry noted. And while bond funds are usually thought of as a safe investment, the price of bonds (and of bond investment funds) goes down as interest rates go up—with investment funds that hold longer-term government or corporate bonds falling in value more than funds holding short-term bonds.

The Federal Reserve is now raising interest rates in an effort to bring inflation under control.

Plan Investments

Defined contribution plan sponsors, Barry advised, "will want to consider communicating with participants about the effects of inflation on asset allocation decisions and retirement income targets, and reviewing the fund menu with a view to making inflation hedges available," such as by offering funds that invests in Treasury Inflation-Protected Securities (TIPS).

Unlike traditional Treasury bonds, as inflation rises, the principal balance of TIPS adjusts upward.

Target-date funds are the most common default investment for 401(k) plans that automatically enroll employees, and many target-date funds allocate a portion of their holdings to TIPS, commodities and real assets that act as a hedge against inflation, the trade publication 401(k) Specialist recently reported.

Many investment advisors suggest that 401(k) plan sponsors review whether their plan's target-date fund contains a sufficient allocation of shorter-duration bonds, TIPS or other investments that protect against inflation.

Rising Interest Rates and Pension Lump Sums

Retirees whose employer provides a defined benefit pension plan often have a choice, when retiring at or after age 65, of taking the pension as a monthly annuity for life or rolling over a single lump sum payout to an individual retirement account.

Stuart Kliternick, an actuary in the New York City office of actuarial and advisory firm Milliman, noted that "as interest rates rise, lump sum values will decrease." However, because pensions apply a one-year stability period during which the plan uses the same applicable interest rate for calculating single-sum distributions, the effect of higher rates on lump-sum calculations doesn't take effect under the start of a new year.

"Participants who recognize this could take advantage of the rising interest rates and request a payout near the end of the year before rates increase for plan calculations," Kliternick noted.

He added, "the possibility of having drops in lump sum amounts of at least 10 percent [next year] might spur more active participants to retire and more participants than expected to take a lump sum."

Retiree Health Dollars

Fidelity Investment's 2022 Retiree Health Care Cost Estimate found that a 65-year-old couple retiring today will need an average of $315,000 to pay for future health care costs, the firm reported on May 16. This year's estimate is up 5 percent from 2021 ($300,000) and has nearly doubled from its original $160,000 in 2002.

"Staying informed on potential future health care costs should remain a top factor when planning for retirement," said Hope Manion, senior vice president, Fidelity Workplace Consulting.

An HSA "can be a powerful way to save and pay for health care, as it allows account holders to pay for qualified medical expenses in a tax-advantaged way, now through retirement," Fidelity noted.

Ron Mastrogiovanni, founder and CEO of HealthView Services, a provider of retirement health care cost data, said that unlike consumer goods and services, "health care costs historically do not increase and decrease—they only go up."

The bottom line for those planning for retirement, he noted, is that "health-related costs will continue to rise across the board, and they will need to save more to address these expenses. For retirees, budgets will continue to be squeezed."

Keeping Focused Amid Stock Market Volatility

Rampant inflation, rising interest rates and concerns about whether a recession is looming have led to a sharp falloff in stock fund values in 2022.

"During periods of economic uncertainty, it's important for retirement savers to stay focused on their long-term savings goals and not make knee-jerk reactions to short-term market events," said Kevin Barry, president of workplace investing at Fidelity Investments.

That's a message employers may want to share with plan participants, given that for many employees the workplace is their only exposure to objective information about retirement investing.

"While the market's performance does impact account balances in the near term, consistent contributions and having an appropriate asset allocation are just as important for a successful long-term retirement savings strategy," Barry noted. "Encouragingly, the majority of retirement savers continued to demonstrate positive savings behavior, which will help keep them on track to reach their goals."


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